India’s credit-starved MSMEs, the GST might unlock a new source of credit

Organizations like the Federation of Indian Small and Medium Enterprises (FISME) estimate that only around 5% of MSMEs access institutional funds through banks and financial institutions. In the absence of funding from mainstream financial institutions, most Indian MSMEs have to rely on the informal lending sector, or their own internal accruals, or borrowing from friends and family, for growth capital.

While the informal sector offers loans at high rates of interest, they tend to issue loans quickly, and with little or no collateral. Internal accruals may often not be sufficient to fuel the growth needs of an MSME, while friends and family are not always an ideal source of growth capital. Thus, a promising engine of economic growth sputters and chokes.

The ministry of micro, small and medium enterprises points out that MSMEs contribute nearly 8% of the country’s GDP, 45% of the manufacturing output and 40% of the exports and provide the largest share of employment after agriculture.

One of the major reasons why banks refrain from lending to MSMEs is lack of reliable financial information. The high transaction costs involved in lending small amounts to MSMEs is another major barrier. India’s Goods and Service Tax Network (GSTN) has the ability to solve both these challenges.

GSTN will bring online seven million organizations and five billion invoices every month. In the GSTN system, the invoices raised by a party have to be accepted by the counter-party for it to be processed further. This ‘deemed acceptance’ means that each invoice is a verified invoice.

This enables bill discounting on a massive scale that was not possible earlier because the cost of verifying the authenticity of invoices was high.

GSTN is one of the largest IT systems in the world, and the billions of invoices flowing through this system will provide lenders with massive amounts of reliable data on MSMEs. When borrowers provide access to their GSTN data to lenders, it will enable lenders to create detailed understanding of the borrower’s cash flows, and create customized credit products. This detailed understanding of cash flows paves the way for flow-based lending. In the absence of such insights, lenders sought collateral to mitigate their risk. For MSMEs that typically do not have much collateral to offer, this can be a significant source of growth capital in the next few years